Castles and Henderson, again

People who’ve been following the debate about global warming closely will be aware that the economic modelling used in projections of future climate change by the IPCC has been severely criticised by former Australian Statistician Ian Castles and former OECD chief economist David Henderson. The critique emerged in a rather confused form, with a number of letters and opinion pieces before finally being published in contrarian social science journal Energy and Environment. Responses, including mine, have been similarly partial and sporadic.

I’ve finally prepared a full-scale response to the main claim made by Castles and Henderson, that the use of market exchange rates, rather than “Purchasing Power Parity” conversion factors for national currencies, biases estimates of future emissions upwards. My conclusion is that although PPP measures are preferable in comparisons of national welfare, the biases introduced by using market exchange rates are not important in modelling emissions and will, on average, cancel out. You can read it all here.

Update: Ian Castles has sent a response which I’ve posted here. It doesn’t seem to me that Ian responds to my argument except to deny that the MER/PPP issue was the main point of the critique.

I should also note that Holtsmark and Alfsen (2004), whose paper I’ve just found, present much the same argument as mine.

Further update In the comments discussion, a fair degree of common ground has been reached. Ian clarifies that he and Henderson object to MER conversion factors, but not because they bias projections of emissions, saying

I agree that these arguments (about the errors in GDP growth and emissions intensity reductions cancelling one another out) are sound as a first approximation.

Ian makes the valid point that use of MER conversion produces the incorrect conclusion that the energy-intensity of LDCs is about the same as prevailed in developed countries when their income was similar. This could lead to misleading policy inferences, for example with respect to mitigation policy and should be corrected.

I agree with Ian that it is better to use PPP measures consistently, and that the sooner the IPCC does this the better. On the other hand, I think it’s important to make the point that the widely-repeated claims that IPCC projections of emissions are fundamentally erroneous because of the choice of exchange rate are not supported by careful analysis.

92 thoughts on “Castles and Henderson, again

  1. Not quite, Terje. But you provide food for thought.

    Surely, according to the ‘labour productivity theory’ which underlies the recent IR law changes, ‘the employer’ wouldn’t wish to fire ‘an employee’ with a marginal product as high as the wages payed to ‘the employees’ in question. Wages are but another name for prices for labour services. Since we are talking about non-union labour in these cases, it seems to me that either the ‘market prices’ paid to these employees in question were ‘wrong’ or these employees were ‘wrongfully dismissed’.

    Now, shareholders are supposed to be ‘the empolyees’ in the cases in question. But the shareholders’ didn’t dismiss ‘their employees’. It was the debt-holders who did it.

    From the debt-holders’ perspective, it is quite clear that there was no ‘wrong-ful dismissal’ because the employees of the shareholders’ defaulted on their financial commitments.

    It is only in a round-about way that ‘the market’ (debt and equity) reveal that there is something not working according to the ‘marginal productivity theory’. While I don’t have detailed knowledge of the G-Cubed model, on the basis of the information available to me, the ‘marginal productivty theory’ equation is in it – at least in the long-run. The non-Walrasian model assumes ‘labour market rigidities’. Well, we foud a few cases where this is true, haven’t we? But, note, the problem we have discovered cannot be solved by removing unions. (I am not saying that there is no problem with union involvement. I am saying the solution doesn’t match the problem discovered.)

    Incidentally, and only tangential to the topic, the residual losses were ‘socialised’ – at least in the case of the insurance companies – and government intervention was involved to organise this. Of course I can’t be sure what would have happened without government intervention but one of the possible outcomes is that ‘nobody’ would have ‘bought’ insurance. To the best of my knowledge, there is nothing in the G-Cubed model which captures the coordinating role of the government; ie to salvage the insurance industry by means of spreading the risk in a manner different from the original risk diversification in the financial markets.

    Let me know whether or not there is any ‘ism-word’ or ideological colour involved in the foregoing. I’d be more than happy to try harder to remove any taint of whatever colour.

    Regards
    Ernestine

  2. Ernestine,

    What you say makes sence, and I don’t see any “isms”. However I thought that the reason companies now went into “administration” instead of “liquidation” when the creditors wanted their money back was precisely because we were previously scrapping otherwise productive entities.

    Also a man is more productive with a shovel and the organisational structure of a firm is in many ways like a shovel. If the firm collapses then it is like a broken shovel. The productivity of the worker rapidly declines and they become overprices. Usually it is not a workers fault when his shovel breaks but it does impact his productivity. Unhappy creditors is a sign that the structure of the firm is breaking.

    Building a firm is in many ways just an exercise in creating a form of social capital. This was the bit Karl Marx missed. He could see the banker brought finance and the worker brought labour but he was not convinced that the entrepreneur brought anything to the table. The answer is structure. And structure if done correctly is worth an awful lot. A good example would be the way Henry Ford restructured production.

    I started my own firm nearly eight years ago and I have thought about this issue of structure for a long time.

    Regards,
    Terje.

    P.S. Ironic that todays capitalists (shareholders) are mostly people of average means and we fret about their rights, while some in the working class (eg CEOs and trade union officials) have become the new social villians that apparently threaten the wellbeing of the capitalists. The game has been turned on its head.

  3. Terje, thanks for your reply. I understand that you do not criticise what I said on the grounds that there is an ideological bias underlying it. And, you acknowledge that ‘ism-words’ are not involved.

    In one of my early posts I mentioned that I am not suitable for ‘debates’ involving, in one way or another, going over past ground and, in my opinion, much of these ‘debates’ involve more sophisticated forms of name-calling, playing the players rather than the ball and I stay out of it. May I ask you to accept this in response to what else you wrote.

  4. not suitable for ‘debates’ involving, in one way or another, going over past ground

    Most debates go over past ground simply because old ground is new to some people. You must find very few debates that suit you.

    May I ask you to accept this in response to what else you wrote.

    You can always ask. And I am happy to accept the response you have just given. If I understand you correctly you are saying that you don’t wish to engage in further discussion of the matter. Nothing wrong with that.

  5. >I would think that there is actually an incentive on the part of oil producing nations to minimise market knowledge about reserves. That way the price is likely to be higher.

    Conversely, reserves and production capacity are used in setting OPEC quoatas so OPEC members have incentives to overstate both.

  6. Louis hissink: “Your last question is easy to answer – no one has been looking elsewhere, hence there is no data, and hence no theory.”

    Yes because as we all know there is absolutely no mining for metalliferous ores or other minerals outside of sedimentary basins and no civil engeering or other tunnelling in areas of igneous rock.

  7. Hi , just discovered this thread. All the debate about GDP glosses over one important parameter in the formula (energy) = a + b*GDP.

    Global warming will only happen if the fossil fuel component in (energy) is greater than 0. Oil prices get higer due to depleting cheap oil and increasing market demand, on a given point alternatives will be really cheaper than fossil fuels, market demand will drop, oil price will drop until production cost is reached. No oil company will produce against a loss.

    The mercury metal price is a good example.

    The SRES A1FI scenario will therefore never happen.

  8. Hans – “Oil prices get higer due to depleting cheap oil and increasing market demand, on a given point alternatives will be really cheaper than fossil fuels, market demand will drop, oil price will drop until production cost is reached.”

    Sure – and every car, truck, bus etc in the world will be instantly converted to run on these alternatives by market forces.

  9. Hans – yes you can however there is not 83 million barrels per day of sunflower oil available – unless of course you want to stop eating so that you can run your car.

  10. The average age of a car in holland is eight years.

    So not instantly, but only in eight years time 50% of the dutch will drive a car manufactured after 2005. New technology spreads fast.

    Take the refrigerator: at the start of the 20th century, a refrigerator was a luxury product as it operated on harvested ice during winter. There was a complete ice harvesting industry north of New York providing the city with refrigerating ice (you may remember a Charlie Chaplin slapstick on the topic.
    Electric refrigerators took over and today you can’t image a household without one. The ice harvesting industry melted away.

  11. Hans – I completely agree however the average half life of the transport fleet is 10 or more years when you consider heavy transport as well that is commonly kept for a lot longer that the average car.

    Eating is not a luxury. Urban populations depend implicitly on oil based transport to supply them with food. At the moment there is no other alternative. The coal that we use to generate most of our electricity is mined with oil based machinery. No oil – no coal. If you started today it takes on average 4 or 5 years to bring on stream a coal to liquids plant. If there is a serious interupption to oil supplies because China is more successful at cornering oil shipments than us then do we just do without eating and electricity for a while?

    How long do you think the economy would stand an oil supply interruption? If we wait until the market gets the signal to change then it is quite likely there could be a gap of 5 to 10 years while the alternatives are brought on line.

  12. Hans – I also like the time of cheap food and water as well. Not really a ghost but a coupled problem with global warming.

    Fix transport first, now, and then we reduce 30 or 40% of greenhouse emissions. Widespread electric transport makes renewable energy viable reducing greenhouse gases further.

  13. jquiggin said:

    January 30th, 2006 at 9:46 pm
    Responding to Warwick [McKibbin], I think the theoretical analysis establishes that the bias can go either way. In saying that 20 per cent doesn’t matter I’m responding primarily to those who’ve claimed that the MER/PPP question discredits the whole IPCC modelling process.

    I don’t buy this. I agree that using PPP instead of MER would be an improvement, but only one among many potential improvements.

    As an aside, note that a 20 per cent gap in 2050 emissions corresponds to a smaller gap in the derived projection of temperature increases.

    I say.

    Great, so we can do without the IPCC since whether emissions without Kyoto may be plus or minus 20% by 2050, there will be a “smaller gap in the projection of temperature increases” [of say 2C + or – 10%?, or 1.8C or 2.2C?]. Kyoto II is unlikely to embody a 20% emissions reduction target by 2050, so why bother?

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